Feeling the heat on debt, earnings

By IBT Staff Reporter On 07/22/11 AT 6:24 PM

New York City may be frying in near record temperatures but Wall Street has been feeling the heat for months. Wrangling over the debt ceiling and questions marks over corporate earnings mean markets are unlikely to get a break any time soon.

Wall Street is set to close its worst three months in a year as July draws to a close next week after a roller coaster ride for markets. Whacked out fund managers hitting the beach in August may find themselves fiddling with their BlackBerrys more than the little umbrella in their cocktails.

I need a vacation, man. After all the stuff that's happened in the last three months I'm pretty much shot, I'm getting weird, even my six-year-old looks at me, said one New Jersey-based fund manager, who was packing his bags for a destination in the Caribbean as temperatures topped 100 degrees Fahrenheit in New York City.

With euro zone leaders having reached a deal for yet another bailout for debt-laden Greece, investors will be free to chew over the rancor in Washington with even more attention.

Negotiations between President Barack Obama and the top Republican in the House of Representatives, John Boehner, still looked far from a deal to avert a looming U.S. default, lawmakers said on Friday, raising the likelihood of more volatility next week if no solution is reached over the weekend.

It's likely an agreement in any form will cause a relief rally for equities, said Glenn Starkman, global head of sales trading at Dahlman Rose in New York.

Coming on the heels of overall pretty good earnings numbers and some sort of resolution in Greece and that could make for a rally in the market, he said.

But on the other side of the coin, the prolonged and partisan dispute over solving the country's debt crisis means there is still a big downside risk.

Who knows where that is going to go, said Nick Kalivas, an analyst at MF Global in Chicago. We're vulnerable to a buyers' strike if we don't get any news.

In addition, the corporate earnings season suggests other risks could dog the market. Despite generally good results so far, there have been some worrisome signs. The S&P 500 rallied 6 percent in the run-up to reporting season, but earnings misses from big industrial names like Rockwell Collins

and Caterpillar Inc weighed on the Dow and S&P 500 on Friday.

Earlier in the week several big consumer names such as Whirlpool and Pepsi warned about sluggishness in developed markets, sending their shares sharply lower.

The market still has a high degree of skepticism in it, said Kalivas, summing up the earnings season so far.

Kalivas said he will be closely following earnings from sector and economic bellwethers next week. Those include the package delivery company UPS , chipmaker Texas Instruments , and online retailer Amazon .

Around 30 percent of the S&P 500's $12.3 trillion market cap have reported earnings so far. They have outpaced consensus estimates by 3.8 percent, and only 7 percent have missed estimates, according to data from Morgan Stanley.

But share prices of those that have fallen short of estimates have taken a severe beating. Given the fragile sentiment a few more prominent misses could derail the market.

The market is punishing these misses more than it is rewarding beats, an asymmetry we have been calling for and we forecast will continue, wrote Morgan Stanley's U.S. equity strategist Adam Parker in a note to clients.

Our view remains that first half of the year numbers are achievable but the second half of the year looks challenged, he said.

Next week is also a big week for economic data. Fears of a slowdown in the economy have been a large driver of market volatility over the last few months, and the coming releases will be parsed very closely.

They include early regional manufacturing data from Chicago and New York, a reading of consumer sentiment, and a first reading of U.S. growth for the second quarter, expected to show the economy grew just 1.9 percent in the period.

Bob Doll, chief equity strategist at BlackRock, one of the world's largest fund managers with around $1.6 trillion of equities under management, said this week that the U.S. economy is at a critical juncture.

Doll points out that since 1960 everytime year-on-year growth has fallen under 2 percent the U.S. economy has gone into recession.

Our bottom line view is that investors should maintain a reasonably constructive bias toward risk assets, but should also be prepared to scale back exposure if evidence of economic growth acceleration does not materialize, said Doll.